Know Your Market

Basic Concepts to Consider when Contracting Milk

Nov 06, 2011

To be a successful milk marketer, a dairy is well served to embrace several time-tested principles of managing milk prices.

By Carl Babler, First Capitol Ag

Contracting milk is a very important management decision. Making a contracting decision requires thought and reason. To randomly decide to contract a quantity of milk for a period of time for a certain price can lead to frustrating results. Before taking on this challenge, it is important first define a few terms:

Contracting Milk– an activity that fixes a cash price or establishes a minimum cash price with a milk processor. These contracts are binding legal agreements to deliver milk.

Financially Hedging Milk– using the tools of the Futures and Options Market to set price or establish a minimum price on a quantity of milk for a period of time until milk is delivered in the cash market.

Marketing Milk – using the tools of the Cash market (through a processor) or the Futures and Options Market to manage or control milk price.

To be a successful milk marketer, a dairy is well served to embrace several time-tested principles of managing milk prices:

No one knows where the milk price is going. Marketing must be accomplished in the absence of a perfect forecast.

Price is right every day. Futures prices and forward contract prices are the aggregate of market expectations and should be viewed in regard to your cost of production and possible return -- and not in light of what your dairy wishes the price to be.

Marketing requires decisive action. Marketing is not about watching, studying and discussing milk price change. It is about doing something with price (fix it or establish a minimum) and then go milk the cows.

Marketing is about looking forward and being proactive. A dairy must constantly view the market opportunities offered forward and not be looking backward at what was or was not done with prices of the past.

Marketing cannot be done by committee. A dairy must delegate market execution to one individual who operates within the marketing plan approved by the dairy’s management team.

A dairy must develop a marketing plan. The plan shouldestablish the quantity to be priced, at what price, at what margin, for what budget, for what period of time forward and with which marketing tools (cash contracts or futures and options).

Contracting milk requires reason. A dairy must have a reason or reasons for contracting price. The following is a short list of good reasons for contracting milk: profitability, price level, market fundamentals (supply and demand condition), price trends and seasonality.

Scale up selling preferred. Selling or fixing price on a portion of dairy's production and adding on to the sale at higher price levels is better than waiting for a "home run price." Hitting singles and doubles is better than striking out while waiting for the home run.

Minimum price strategies work best for milk marketing. The characteristics of milk price distribution over time favor marketing actions that allow for dairy to benefit from higher prices. Establishing a minimum price on all production is highly advised as a first step in milk marketing. Buying call options to cover cash contracts or sold futures positions is a good fit when pricing milk.

Consistency pays off. Systematically applying a marketing plan over a long time period beats randomly picking and choosing when and what to do with milk price.

Have fun. When structure, purpose and a plan are at the center of milk marketing actions, then frustration can be replaced with fun.

The above-listed considerations are not assumed to be all inclusive and other concepts may be equally essential. However, contracting or hedging milk price in the absence of marketing principles can lead to lost financial opportunity.

Carl Babler is a senior hedge broker with First Capitol Ag. Associated with First Capitol Ag since 1990, Babler also is a part-time lecturer at the University of Wisconsin-Platteville and owns a 1200-acre grain farm. E-mail him at cbabler@firstcapitolag.com.